21 – Critical Principles For Cost Systems

Cost Systems

Systems are the structure and provide the environment for business.
Pierre Guillaume

Critical Principles for Cost Systems

Pierre Guillaume introduces the principles that must govern a cost system. He introduces the first two principles in this series: Providing Transparency; and Establishing Ownership.

Alan StrattonWhy Have A Cost System

Alan Stratton responds to a viewer’s frustration with his CFO’s reluctance to implement an effective cost system. Part 1 of 2 of this response.

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In episode 21

Coming up on this episode of Performance Management Edge… Principles governing cost systems and Why have a cost system?

I’m Alan Stratton and this is the show that helps you get an edge in business. This is the edge you need to get things done, to soar above the masses, and to make more money.

Cost Systems

Systems are the structure and provide the environment for business. We both love them and we hate them. At times, it seems that we’re working for the system instead of the system working for us.

In this episode, Pierre Guillaume introduces a new three part series on cost systems; principles that we should follow to make systems work for us. Then we’ll deal with a viewer’s frustration with his CFO.

First, over to you – Pierre.

Pierre GuillaumeCritical Principles for Cost Systems

Hi, this is Pierre Guillaume again, from Beyond EPS Advisors, in the first segment of a three part series on the principles that should govern a cost system. We have identified seven principles that should guide any company thinking about implementing a new costing system. They should guide the design of the system if one wants to insure its long-term success.

The seven principles are:

  1. Provides transparency
  2. Establishes Ownership
  3. Follows Cause and Effect Relationships
  4. Seeks Consistency
  5. Considers Behavioral Consequences
  6. Achieves Compliance
  7. Delivers Value

Today we will cover the first two and we will be pick up the other principles in subsequent segments.

The first principle we will examine is transparency.

Any company’s costing system should provide transparency to its users. Too often, we see systems that are perceived as black boxes by the users. Transparency comes from having the ability to track costs back to the origination. Users should be able to see how these costs flow to their respective areas. The principle of transparency means that costs should be evident, obvious and easily understood. This includes the ability to see and clearly understand the underlying assumptions about how costs are determined.

The breakdown of costs should provide a complete audit trail that can be used by managers and stakeholders, and in response to regulatory authorities. This cost breakdown will help answer basic cost questions such as:

  • What costs are included in that number?
  • Where did those costs originate?
  • How were the costs driven through the system?

Transparency is fundamental for establishing confidence in costs. This principle provides an audit trail of what is in the numbers. Summary totals may be adequate for presentation, but users should be able to drill back to the detail cost elements, enabling them to understand what makes up that cost.

Note here before we move on to the next principle that transparency doesn’t equate to accuracy: costs may be allocated in a very transparent way but totally inadequate manner. Conversely, the methodology used in the black box we mentioned earlier may be accurate and precise, but this won’t help if the users do not understand it.

The second important principle is ownership.

Any user of the costing system should be clear about ownership of costs. A cost is defined as a resource sacrificed or forgone to achieve a specific objective. Knowing which individuals or units are responsible for achieving the specific objectives is critical to managing the business.

Accurate decision making depends on knowing:

  • Who is responsible for a specific cost,
  • Whose daily performance is tied to that measure, and
  • Who owns the cost or can make decisions based on that costing information.

Ownership of costs is needed to inspire confidence in the costing information, regardless of the cost methodologies, systems or tools used.

Understanding ownership of costs can be straightforward such as when a business unit elects to run a specific direct-mail campaign. It is clear that the resources sacrificed (in this case printing costs, postage, marketing time, etc.) are spent to obtain the benefit of new accounts in that business. Managers making those decisions have ownership of those costs as well as the results.

However, there are also many situations where the resources are shared by multiple decision-makers. An example would be a call center operated by a shared service organization. This call center supports multiple external lines of business. Generally, the operational area is responsible for the rates they provide while the consuming lines of business are responsible for the volumes. A clear understanding of cost and volume ownership helps service providers and consumers to achieve high levels of communication and cooperation.

I hope you found these thoughts helpful as you reflect on the needs of your costing system. Next time we will talk about the next two principles that we have identified.

Thank you Pierre. If we manage based on principles, decisions become easier and more consistent.

Let us hear your opinions. Pierre and I would love to hear your experience and comments on Cost System Principles. What has worked for you? Scroll down the page at Performance Management Edge dot com and let us hear your opinion.

Alan StrattonWhy Have a Cost Systems

Now for today’s question.

“Our CFO believes we don’t need a costing system. We already have a general ledger and track expenses to all departments and a budget system to collect expense estimates. In his opinion, a costing system would be a waste of money.”

To respond to this question, I’ll ask a couple of questions:

  1. What is a system? Let’s quote from Wikipedia:

“A system is a set of interacting or interdependent components forming an integrated …

“Most systems share common characteristics, including:

  • “Systems have structure, defined by components/elements and their composition;”
  • “Systems have behavior, which involves inputs, processing and outputs of material, energy, information, or data;
  • “Systems have interconnectivity: the various parts of a system have functional as well as structural relationships to each other.
  • “Systems may have some functions or groups of functions

“The term system may also refer to a set of rules that governs structure and/or behavior…”

I would add that a system is opposite of ad hoc or spur of the moment. A system makes work and things repeatable, whether decision systems or production systems or whatever system. A good system enables quality thru standards and repeatability.

A system in business does not have to have a computer involved. But given the power and repeatability of modern computers in handling information, we often assume a system is a computerized. However, we still need to remember that computers are here to serve humans; humans are not servants to computer systems. This also means that you should not turn systems implementation and management completely over to your IT function. They understand information processing but not always the business context.

Whoops, this answer is getting a little long – I’m out of time. I’ll continue this response in the next episode. Meanwhile, go back and replay Pierre’s segment and review the principles that should govern a cost system.

Per his request, we’ve withheld this viewer’s name – but thank you again for the question.

Now to our viewers. Do you agree, or Not? How can you apply what you have heard in this episode? Whatever it is, let’s hear your viewpoint. Please share your view below this video at Performance Management Edge dot com.

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In appreciation for his question, we’ll arrange a time for this viewer to have a 30 minute telephone or Skype discussion on topics of his choice with one of our experts. And, we’ll send him a copy of “Best Practices in Planning and Performance Management” by David Axson. After you’ve read this book, pass it along to your CFO. It sounds like he needs to read it also.

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